Turkey's central bank on January 24 left its benchmark interest rate on hold, causing the Turkish lira to immediately nosedive by 1.6% against the dollar and disappointing investors who saw the monetary policy decision as a missed chance to demonstrate the regulator's independence from government pressure.

The lira sank to 3.8019 immediately after the central bank announced it would keep its benchmark one-week repo rate at 8%, defying market expectations for a 50bps hike. Analysts will now revisit the issue of whether the bank's board is responding to pressure from Turkish President Recep Tayyip Erdogan and government leaders who insist the Turkish economy needs lower rates that would further open the credit taps. Given Turkey's rising inflation, that approach flies in the face of economic orthodoxy, according to observers.

In its statement on the latest decisions from the central bank monetary policy committee (MPC), the national lender added that it had increased the overnight lending rate from 8.5% to 9.25%, while leaving the overnight borrowing rate at 7.25%. It increased the late liquidity window rate from 10% to 11%.

By 14:40 local time, the lira had recovered some ground to trade at 3.7879 per dollar.

The currency has been under strong selling pressure because of a toxic combination of political uncertainties, geopolitical risks and economic woes. The battered lira has fallen nearly 7% since the start of the year, making it one of the worst performing emerging market currencies.

The central bank has tried to stop the lira’s decline by tightening liquidity conditions, but the impact of these measures proved short-lived and thus failed to support the currency.

“We expect Turkey’s central bank to hold the benchmark repo rate unchanged on 24 January as political pressure to keep the economy growing prevails. A 50-100bp ‘cosmetic’ hike is still likely,” Danske Bank said in a commentary released on January 24, ahead of the MPC meeting.

Now, all eyes will turn to Fitch Ratings which is expected to announce its rating review of Turkey on January 27. Two other major rating companies Standard & Poor’s and Moody’s Investors Service downgraded Turkey to junk in 2016, leaving Fitch as the only agency keeping the country at investment grade. A downgrade may exert further pressure on the lira.

“Inflation expectations, pricing behaviour and other factors affecting inflation will be closely monitored and, if needed, further monetary tightening will be delivered,” the bank said in a statement released after the MPC meeting. “Moreover, necessary liquidity measures will be taken in case of unhealthy pricing behaviour in the foreign exchange market that cannot be justified by economic fundamentals.”

The bank also said it would continue to use available instruments in pursuit of the price stability objective. But, it warned that “the significant rise in inflation is expected to continue in the short term due to lagged pass-through effects and the volatility in food prices”.

The bank expected the recovery in economic activity to continue at a moderate pace, noting that: “Demand from the European Union economies continues to contribute positively to exports, while domestic demand displays a weaker course.”

Earlier this month, the World Bank slashed its 2017 GDP growth projection for Turkey to 3% from its previous forecast of 3.5%, citing political uncertainties and financial market volatility. The government’s GDP growth estimates for this year and next year are 4.4% and 5%, respectively.